BUILDERS, iBUYERS AND THE WAR ON BROKERS

Last year, there were about 6.5 million closed home sales in the US.  If you assume 80% of those deals were properties listed in the MLS with broker representation, that works about to about 5.2 million "commissionable" transactions.  

With an average sales price nationally of about $400,000, and using a conservative estimate on gross commissions charged, that works out to about $100 billion in real estate commissions paid to the 2 million or so licensed agents in the US, or about $50,000 per licensee before expenses, licensing fees, transactional costs and broker splits.

All well and good, except that $100 billion in commissions has become a very attractive target to tech companies, disintermediators and, most recently, certain home builders like Lennar and Richmond, who have decided to reduce or fully eliminate commissions paid to brokers as a carve out on that $100 billion pie.

The reality is that the average real estate agent earns about $30,000 a year, which is one reason real estate is the ultimate revolving door business. While appearing fun and glamourous from the outside, in real life it's an endless grind of showing properties (often at the direct expense of your spouse and children), competing for listings, solving problems and managing emotions, made far worse by the historic inventory plunge triggered by the loose money Fed policies enacted at the onset of the pandemic.

Nationally, 50% of licensees will quit in their first year, and nearly three out of four new agents will not renew at the end of their first three or four-year license cycle.  

Zillow has significantly altered its business models over the past few years, transitioning from an advertising platform to a lead generation service to a brokerage company to a home flipping service, with disastrous results.  

They saw that $100 billion in commissions just hanging out there, like a giant piece of candy just beyond their reach, and fell of a cliff in pursuit of it.  

Like their home flipping competitors Open Door and Offer Pad, Zillow thought if they just bought enough market share, they could eventually make people comfortable with selling directly to them, buying directly from them, financing with them and leveraging a host of affiliated businesses like insurance and contractor services to take over the world.

In pursuing this strategy, they alienated the agents who advertised with them, alienated the brokerages that used to partner with them, alienated the home sellers they lowballed, and alienated home buyers dumb enough to overpay for smoky, dirty, overpriced properties with bad carpet that became the expectation when you saw a Zillow sign in the front yard.

They also announced they will lose more than $550 million in the second half of 2021 alone, which tanked their stock by more than 20% when the announcement came at the beginning of November.  

As referenced earlier, Lennar is now one the builders who have declared war on brokers and commissions.  And no, they don't plan to share those savings with you.  Lennar has actually doubled down on attacking brokers by partnering with Open Door, hoping that when you walk into that sales office unrepresented and find out you need to sell your home in order to be a non-contingent buyer for one of Lennar's new builds, you'll chop off your right forearm and sell directly to Open Door (at a steeply discounted price) to satisfy the contingency.

Again, all well and good.  I'm all for different business models.  Seriously, it's a marketplace and ideas and models should be in competition with one another.  

But if you're going to try and squash me, it's hard for me to offer a hearty endorsement of your product when your business model involves removing the experience, commitment and fiduciary expertise of good brokers from the transaction so you can sell directly to consumers who have no idea how many hand grenades are buried in a 50-page builder contract (written by the builder's attorneys).

So it's a marketplace, and if you want to destroy me, don't expect me to offer a recommendation to my buyers.

I've said for a while that a great die-off is coming in the real estate world, and it has arrived since March of 2020.  For both agents and brokerages, if you don't have a compelling value proposition, you are headed for extinction.  

And that's okay too.  Again, I'm all for markets and a competition of ideas and services.  Let Open Door and Offer Pad buy crappy homes and slap lipstick on them.  Let builders roll the dice on letting unrepresented buyers sign one-sided purchase agreements that strip away their rights without disclosure or understanding.  Let consumers decide what works for them.

Zillow discovered that chasing what looked like $100 billion in low hanging fruit ruined their brand integrity and threw their company into organizational chaos.  I wasn't the only one who noticed that when Zillow started flipping homes, their appreciation estimates went from some of the most conservative in the automated arena to the most aggressive.

It's hard living through disruption, but Americans in all walks of life have been going through it for 21 months now.  Real estate is no exception.  If you think an honest, experienced broker adds value, then hire one.  And if you don't, call the 800 number on the post card in your mailbox and give away 10% of your equity to someone who isn't based in your community, will provide little or no service and has no regard for your best interests.  

IS DISTORTING THE TRUTH IN THE CONTRACT GOOD AGENTING OR A BREACH OF ETHICS?

In the madness that is the real estate market of 2021, I must admit it took me a while to realize how many people were "cheating" when writing contracts to buy and sell. 

Perhaps "misrepresenting" would be a better term.

Nah, let's just call it what it is.  Lying.

With so many properties drawing five to 15 offers and competition at a level that is hard to describe to a normal, non-real estate industry employed civilian, contract writing has become a topic of much conversation.  

Historically speaking, many sellers (and agents) have equated larger down payments with stronger buyers.  In other words, with 10 offers on a home, you have to come up with some mechanism for sorting, and down payment size is an easy one.

Larger down payment buyers, the theory goes, have more resources and therefore have better ability to deal with low appraisals and inspection requests that sellers more often than not simply toss in the trash can these days.  

A lower down payment buyer (less than 20%), the theory goes, are already pushing all of their chips onto the table just scraping together a 5% or 10% down payment.  When they offer $600k for a home and it appraises at $550k, they're dead because they don't have extra resources to bring to the deal.  (And in the one-sided rout that is the Denver real estate market of 2020-21, it's highly unlikely a seller is going to lower the contract price when there are nine other contracts stacked up on the kitchen table)

So one interesting "strategy" many agents seem to have adopted is... lie about it.  

Section 4 of the Contract to Buy and Sell lays out the grid showing the purchase price, earnest money deposit, loan amount and cash due at closing.  The purpose of this paragraph is to show the seller, quickly and concisely, what kind of resources the buyer is bringing to the transaction.  

Section 29 of the purchase contract is called the "Good Faith" provision, and it states that buyer and seller agree to work in good faith to honor the terms of the contract and failure to do so shall be grounds for default.

So what happens when a buyer states they have 20% down when they really only have 5% down?  Are they breaching good faith?  

The answer, as is so often the case in life, is "it depends".  

Section 4.5.2 of the purchase contract actually gives the buyer the right to change financing terms, as long as the buyer stays within the same financing type (cash, conventional, FHA, VA, etc) specified in the contract.  

So this can be interpreted to allow a buyer pledging a 20% down payment to close with a 5% down payment, assuming the financing type is the same as originally specified in the contract.  The gray area here, in my opinion, is could the buyer claiming to have 20% down and attempting to close with just 5% down actually have honored the original down payment commitment in the contract, or not?

Because if that buyer never had 20% down, I think it's arguable (if not obvious) that buyer is not acting in good faith and thus is in default.

As I said at the beginning of this post, I'm late to the party on this because it was only after I began to see buyers claiming to have 20% down on my listings show up at closing with a much smaller down payment amount that the alarm bells went off in my head.

In theory, if the seller believes the buyer has not acted in good faith, that seller could refuse to close, claim the buyer's earnest money and leave the buyer high and dry.  Of course, the buyer would then likely sue the seller, who has a good chance of winning in mediation or arbitration unless the buyer can prove he or she intended and was capable of bringing the larger down payment to the closing table. 

But at the end of the day it's all a giant fistfight over ethics, integrity, honesty, honor and, of course, good faith.  

If lying is part of your contract writing strategy, I would say your desperation is getting the best of you.  But if your client legitimately could bring 20% down, but then downsizes to 10% when the appraisal comes in low and then realizes the home needs paint, carpet, siding and a new roof... well, in that case reducing the down payment is understandable and, in fact, logical.

With desperation a key ingredient driving buyers and their agents in a hopeless low-inventory environment, it's increasingly common for misrepresentations to be made intentionally and strategically.  

It's one reason why the forms committee is about to release a major re-write of the Colorado Contract to Buy and Sell in 2022 - perhaps the biggest set of revisions to the contract in 20 years.  

The contract is going to get longer, it's going to get clearer, it's going to incorporate more penalties and it's going to strip away some of the key ambiguities buyers and their agents have been exploiting to cut to the front of the line in multiple offer situations (which is pretty much everything in Denver that isn't a meth lab).  

There are 100 reasons why 2021 has been the most challenging environment I have ever experienced in 27 years as a broker, but having others intentionally misrepresenting buyer qualifications on the purchase contract over and over again is one of the offenses I am most done with.  

THE OTHER SIDE OF THE CRAMDOWN COIN

I'm old enough to remember the summer of 2019, when the following things happened:

- Mortgage rates went to 4.5%

- The inventory of homes for sale rose to more than 11,000

- Good listings began sitting on the market for weeks with little or no interest

- Prices flattened and the market appeared to be, at long last, running on empty

Then, as you know, the pandemic hit.  And with it, rates went to the mid 2's.  Inventory disappeared and bidding wars began.  Bidding wars intensified and we then went to frenzy mode.  Overall active inventory fell from more than 9,200 listings in April of 2020 to 1,878 by the end of the year.  Prices went up 20%.  Everyone lost their minds.  Buyers (correctly) felt (and continue to feel) hopeless.  Sellers (correctly) felt (and continue to feel) emboldened.

And with that sea change in sentiment, the cramdowns began.

No need to get definitionally fancy here.  A cramdown is simply one side imposing its will on the other, with little regard for real or perceived fairness, mercy or ethical balance in a transaction.  

Where it shows up most is with inspections and appraisals.  Sellers aren't fixing much and if it doesn't appraise (which it probably won't), then tough.  Also, the sellers would like a free 60 day rentback, earnest money "hard" (non-refundable) early in the process and if you're even going to bother asking for an inspection (which might just cause them to toss your offer in the trash right off the bat), don't forget to turn the lights out when you leave.  

Market conditions dictate negotiations, and with artificially low rates driving a 90 mph tailwind, home prices are soaring into the stratosphere.  Buyers courageous enough to brave these conditions are expected to show up, smile and take their beatings like good little soldiers.  

For now.

It's a wildly unhealthy climate and it comes with risks.  We are engaged in the biggest money-printing binge in history (hello Modern Monetary Theory) with mortgage rates artificially dragged down to less than half the rate of inflation, which is totally illogical and makes no fiscal sense in any sane universe.

Ah, but I said "sane" - that's the catch.

We are living in insane times with monetary policy that reflects the insanity.  

If the Federal Reserve was following its longtime mandate of keeping inflation at 2%, mortgage rates would be 5% or higher right now and the so-called market would be flat on its back.  

The only way to kill inflation is with higher interest rates, which nobody wants to do because we have this little issue of $29 trillion (and counting) in federally financed debt, and if you raise rates, the country basically goes bankrupt and defaults on its debt.  

So we keep pretending that 3% mortgages and endless money printing will work great forever, which is dubious policy at best and reckless endangerment of our entire economic system at worst.  Inflating your way out of unsustainable debt is not a strategy - it's a conspiracy, and it certainly appears that the Fed is all in on printing money for as long as it takes to mitigate the impact of US debt.  

(And, alternatively, if you know that endless money printing is likely to continue and rates will stay low until the whole systems breaks, those crafty Fed bankers get to move their own investments into assets that are inflation-protected hedges like gold, silver, and real estate)

You can only drive 90 mph for so long until you encounter a sharp turn, and at that point it will be interesting to see if the Fed can successfully navigate the hairpin or if we go blasting through the guardrail, over a cliff and land in Venezuela.  

But I digress.  

The original intent of this post was to talk about cramdowns, and if you're selling a home or thinking about it in the coming months, remember this.  

It won't always be this easy.

When this market stresses or breaks, with prices that are so far beyond wage growth and incomes as to make inquiring minds like mine woozy with overwhelm... this whole notion of cramming down ridiculous terms on buyers will flip.  

And while I think prices will hold most of their gains because of money printing and the fact we simply can't build affordable homes anymore, what will change is that buyers won't simply roll over and take it when the furnace is 20 years old, the roof is splattered with hail damage or there's a 30 foot belly in the sewer line.  

When the pendulum finally swings, I expect buyers to be relentless and without mercy in their demands of sellers to provide homes in a condition that matches the over-the-moon valuations of 2021.  

If you have something to sell, I would look seriously at selling it - sooner rather than later.  And double down on that if it's a home that is less than perfect.  

When this market eventually slows, you may not see huge price reductions, but you will see a very different world in terms of inspections, appraisals, reasonableness and leverage.  

So enjoy your season of cramdowns, sellers.  

While it lasts.  

FIVE WAYS WE COULD SEE MORE LISTING INVENTORY IN 2021

With fewer than 1,900 active listings on the market and more than 6,200 homes currently under contract in the metro area, this is the most inventory-starved, one-sided market in the history of Denver.  

And it's not even close.

Each of the past four months has represented an all-time low for active listing inventory.  Our current number of 1,878 active listings is down 27% from one month ago, down 55% from three months ago, down 72% from one year ago and down 80% from when the market re-opened last May.

It's also down 56% from our previous all-time low of 4,203 active listings, which happened in December of 2017.

The reasons for this have been discussed here before - Covid-19 fears, eviction and foreclosure moratoriums, concerns about whether jobs will return (or be retained) after the pandemic ends, and the Fed's incendiary low rate policies that have created the mother of all frenzies among the buyer class. 

So what could happen in the coming months to change this?  Certainly, it has to change at some point, but what key drivers could make this happen sooner rather than later?

Here are five potential game changers:

TAX POLICY FOR INVESTORS - Whether it's changing tax rates on investment gains from capital gains to personal income (already proposed), capping or eliminating depreciation (it's been talked about) or eliminating 1031 exchanges altogether (unlikely since so many lawmakers are real estate land barons), landlords and investors are likely going to get whacked hard in whatever tax bill is coming out of Congress in the next few weeks.  If these changes are made effective January 1, 2022, it would give landlords time (and massive incentive) to get out of their rental portfolios this year.  If changes are made retroactively to January 1, 2021, then investors and landlords would have no exit strategy and it would make the inventory problems worse since they would never sell.  If you're going to do tax reform in an effort to free up more entry-level housing, there's a right way and a wrong way to do it.  I'll let you decide what the odds are of Congress doing this the right way versus completely blowing it.

PRIMARY RESIDENCE EXEMPTION - Under current tax law, owner-occupants who have lived in a home just two of the past five years are generally able to sell their principal residence with a tax-free capital gain.  This truly is one of the most generous provisions of the tax code and it has created massive windfalls for many homeowners, especially in historically hot markets like Denver.  In 2017, the GOP tax bill proposed changing the qualification for this exemption from "two of the past five" years to "five of the past eight" years.  You may see another attempt to take some of the sugar out of this very sweet tax break in the coming months.  Just as with our tax policy discussion above, there's a right way and and a wrong to do this if the goal is free up more housing.  Making it effective January 1, 2022 would create urgency and incentive.  Making it retroactive would have the opposite effect.

FORECLOSURE AND EVICTION MORATORIUMS - Again, we are living through a complete manipulation of the markets due to emergency government and Federal Reserve interventions.  Just this morning, the Biden Administration extended (again) foreclosure and eviction moratoriums until the end of June.  In simplest terms, what this means is anyone with a mortgage owned by Fannie Mae or Freddie Mac (the two government-sponsored enterprises that own about two-thirds of all mortgages) is exempt from even the initiation of foreclosure proceedings until at least June 30, 2021.  If the moratorium is not extended (and at this point, who knows if delinquent homeowners will ever need to make another payment?), then banks could send out foreclosure notices effective July 1, 2021.  If that happened, delinquent homeowners would have 90 days to bring their mortgages current or work out an agreeable repayment plan, or the banks would have the right to foreclosure.  Let's be clear, we're not going to see foreclosures because the inventory constraints brought about by government policies around Covid have driven prices even higher into the stratosphere.  Owners struggling with making payments would have to sell to avoid losing their properties to the bank, but virtually no one is actually going to make it to the point of facing foreclosure when selling would result in such significant gains.  

A RISE IN INTEREST RATES - This is the scenario no one wants to see, because when it happens, it's going to have severe consequences.  Home buyers are now addicted to 2.5% mortgage rates and our market is totally dependent on this cheap money for its continued viability.  When rates go up, and it will happen at some point, the buyer pool will thin with each corresponding uptick in rates.  When rates get to 3%, you're going to price a certain portion of the buyer pool out.  When rates get to 3.5%, even more will disappear.  And if we get to 4%, I think demand will be significantly impacted in the short term unless the government comes up with another creative and unprecedented way (50 year mortgages? Mortgage portability? Negative bond yields?) to keep the market liquid.  

ANOTHER BLACK SWAN EVENT - Let's face it, we're tired of talking about Covid.  Economically, the pandemic has had a bruising impact on the economy and we are staggered, to say the least.  The Fed has shifted into money printing mode (the Treasury technically prints the money, but Fed Policy dictates it) and there are serious inflationary concerns on the backside of this Black Swan event.  But what another Black Swan like a terrorist attack, military conflict or even an extreme weather event?  It takes confidence in the future to buy a home, and with the discount rate at 0.25% and mortgages in the 2's, the Fed has dragged borrowing rates to the lowest point possible without negative rates, which could be a thing if we hit any more calamity.  The buyer pool is fueled by cheap money and some degree of confidence in the future.  If either of those is called into doubt, you'll see more inventory and fewer buyers.  

The reality today is that we are all bracing for significant change in the near future that is going to reshape the landscape for both current and future homeowners.  The policy prescriptions coming over the next few months are going to have huge consequences for the future of real estate and at this point, most of us are simply guessing at what that future will look like.  

Right now, we have an overload of buyers and zero inventory.  There are several scenarios where that could change fairly quickly.